(July 10): Carry trades — one of the most widely-used strategies in the US$9.5 trillion ($12.3 trillion)-per-day currency market — are seeing the most compelling backdrop in more than two decades, according to Goldman Sachs Group Inc.
Betting on carry bears more relevance in the Group of 10 foreign-exchange space than at almost any point since 2000, strategist Stuart Jenkins wrote in a report. Goldman currently favours funding the trades using the yen, Swiss franc or euro in the months ahead, he said, referring to the technique of borrowing in a relatively low-yielding currency and investing in one where they are higher.
Several factors have catapulted the trade’s appeal. Goldman said interest rates across the world’s biggest developed economies have settled at high and varied levels, creating unusually wide yield gaps for investors, while currency volatility has dropped to historically subdued levels. An index by JPMorgan Chase & Co shows foreign-exchange volatility is hovering near its lowest levels since 2020.
That combination has helped G10 FX carry trades return about 8% this year, beating global bonds, gold and bitcoin, though still trailing stocks, according to data compiled by Bloomberg.
“It is the stabilisation in this range of G10 rates — with reduced realised vol from rate differentials, and relatively limited policy action expected ahead — that has helped allow for this higher G10 carry to coincide with more muted vol,” Jenkins wrote in the note published Thursday.
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Hedge funds to asset managers use the carry trade to exploit rate differentials between markets, as long as the exchange rates remain broadly stable. But the strategy comes with risks. Because income accrues gradually while currency losses can materialise in a matter of minutes, a sudden bout of volatility can trigger a rapid unwinding of positions and amplify swings across markets.
Barclays Bank Plc also warned this week that the current calm in currency markets is at odds with elevated global economic uncertainty. The bank said its model suggests volatility is more likely to rise than fall from here.
Two-year note yields remain above 4% in the US, compared with 2.6% in Germany, 1.4% in Japan and about 0.1% in Switzerland, leaving some of the widest rate differentials across developed markets.
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Top candidate
Goldman said the yen is a top funding candidate over the longer term. Japan’s currency is trading near a 40-year low versus the dollar, and while the threat of official intervention is ever present, the bank expects it to keep weakening unless there’s a change in the macro backdrop.
The Wall Street firm also sees opportunity in buying the dollar against the Swedish krona. In so-called “risk-neutral” scenarios, it favors purchasing the euro against the Swiss franc, which it says offers one of the highest carry-to-volatility profiles among major currency pairs, as well as Aussie against the kiwi.
The Wall Street firm also sees opportunity in buying the dollar against the Swedish krona. In so-called “risk-neutral” scenarios, it favors purchasing the euro against the Swiss franc, which it says offers one of the highest carry-to-volatility profiles among major currency pairs, as well as Aussie against the kiwi.
“We view the opportunity to earn carry in G10 FX while remaining relatively insulated from, or even hedged against, drawdowns in risk as a useful option in multi-asset portfolios,” Jenkins wrote.
Uploaded by Magessan Varatharaja
